Illumina - The 'Google Of Genetic Testing' Looks Like A Buy

| About: Illumina, Inc. (ILMN)
This article is now exclusive for PRO subscribers.

Summary

Illumina dominates the market for genetic sequencing machines.

The company has enormous future potential, as personalized medicine is the future of healthcare.

This week's 20% sell-off represents an attractive buying opportunity.

One of the biggest future trends in healthcare is personalized medicine.

Personalized medicine refers to medical care based around the genetic makeup of an individual.

The list of advantages of personalized medicine over today's treatment models are stark and exciting:

  1. Extremely early screening for potential mutations that lead to certain diseases - as early as before birth. Preventative measures can then be devised.
  2. Focused treatments. Different individuals respond to certain treatments differently. Personalized medicine will allow doctors to choose the best and most effective treatment for each individual patient, rather than the "trial and error" that occurs today.
  3. Drugs can be formulated slightly differently to achieve maximum efficacy and safety based on an individual's genetic profile.
  4. Having genetic information to reference against will be a huge advantage in the battle against Alzheimer's and other cancers thought to be linked to DNA mutations.

Why bring up personalized medicine?

Because one of the stocks in our Quality Growth Spell - the undisputed leader in genomic sequencing - just fell over 20% this week and is trading at one of its lowest prices in the past 2 years.

Seems like a good time to check it out! Let's take a look at Illumina (NASDAQ:ILMN).

The Google Of Genetic Testing?

Wired magazine recently ran a great article on the company, which it referred to as the "Google of Genetic Testing".

Pretty high praise. Is it true?

Illumina's primary business is selling DNA sequencing machines. New hardware accounts for about 30% of revenue, while consumable supply sales are over 55% and an emerging services business is about 15%. Illumina dominates this market. Its machines generate nearly 90% of all DNA data produced today!

Already, we are seeing a lot of things we like in a business. Its competitive advantages are strong, as in most cases Illumina's customers have invested a substantial amount of time and money in its platform, so switching is difficult. By scale and reputation alone, Illumina is a default vendor for many new customers as well. 70% of revenue is reliably recurring.

However, the long-tail growth potential here is what is most enticing. The company has done well, with a 5-year compound annual growth rate of about 20%. But think about this: have you had your genome sequenced yet? Less than 0.01% of the world's population has. The total number of sequences done in all of 2014 was only about 200,000. The ramp up for this medical "revolution" has barely gotten started. And that's not to mention all of the alternative potential uses for a DNA scan... think of Ancestry.com's DNA offering.

This is not a value stock. The trailing 12-month earnings yield is 3.1% and free cash flow yield is 2.9%, so growth is implied in the valuation. But the future potential seems limitless for Illumina as it expands into testing services. I feel the company has barely scratched the surface of its potential.

Why the Sell-Off?

Illumina sold off over 20% this week after revenue guidance missed targets due to slower system sales, particularly in Europe. In fact, system sales have been sluggish for the past 9 months.

This looks like a good opportunity to take a bite of the stock. High-priced hardware sales have historically faced some cyclicity. What would be more worrisome is if we started seeing signs of smaller competitors like Pacific Biosciences (NASDAQ:PACB) or Genia taking market share. On its way up, Illumina passed many legacy players, such as Affymetrix (NASDAQ:AFFX) and 454 Life Sciences.

One thing that concerns me a little more is the stepping down of long-time CEO Jay Flatley, the man behind much of Illumina's success. While Flatley isn't leaving - he's staying on as executive chairman - it is still a big loss and leaves question marks at the top. He will be succeeded by former Symantec (NASDAQ:SYMC) and Intel (NASDAQ:INTC) veteran, Francis deSouza.

Conclusion

You don't often get good opportunities to buy into dominant players in enormous future growth markets at reasonable prices, but I believe that is exactly what we are getting right now with Illumina. This is one stock investors can buy and hold for the long term as the huge potential of personalized medicine is realized.

Disclosure: I am/we are long ILMN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.